Daniel Zurbrügg's InstablogDaniel Zurbrügg is the Managing Partner of Swiss Infinity Global Investmetns GmbH(http://www.swissinfinity.ch), a Swiss based independent asset management firm. The firm provides clients with independent investment research, asset management and asset protection services. With a global network of partners, Swiss Infinity's aim is to provide clients with a true "turnkey" solutions for offshore asset management and global diversification. Daniel Zurbrügghttp://seekingalpha.com/author/daniel-zurbrugg/instablog
Special Focus: Low Yields Forever? Explaining The Interest Rates Conundrumhttp://seekingalpha.com/instablog/324650-daniel-zurbrugg/3332855-special-focus-low-yields-forever-explaining-the-interest-rates-conundrum?source=feed
3332855
After rising to around 3 percent last year, the yield on 10 year U.S. Treasury bond has reversed course and recently moved as low as 2.30%. It seems like they continue to move lower toward the record low seen in 2012, when the 10 year Treasury bond yielded around 1.85%. Despite a small uptick in yields, it is rather surprising, especially considering the fact that the Federal Reserve is about to wind up its Quantitative Easing program, given the improvement in the economy and the falling unemployment rate, which currently stands at 6.1%. Interest rates are moving lower despite an improving economy? Something does not seem to be right here because normally rates should move higher as a reaction to a stronger economy and in light of a further normalization of the Fed's monetary policy. What is pushing yields down and what do the lower rates means for the outlook of the economy? We try to analyze this and give some answer to the new but old interest rates "conundrum".

In 1996, the former Federal Reserve chairman Alan Greenspan used the term "irrational exuberance" to describe what he believed was a stock market bubble. He simply couldn't explain the rather rapid increase in equity prices seen in the early 90's. Only very few people back at that time would have thought that equity markets were nowhere near their top, they continued to climb for another three years before their sharp correction early in the new millennium. Between 1998 and 2000, the Fed Funds rate rose from around 4 percent to 6.5 percent before the stock market started a large correction and the economy began to slow as all the hype and enthusiasm about the new age of technological revolution began to fade. In order to support the economy, the Federal Reserve began to lower interest rates and within less than 2 years (!!), the Fed Funds rate fell below 2 percent and eventually bottomed out at 1.5% in 2003/2004. The yield on 10 year Treasury bonds had fallen to around 4 percent which even surprised the Federal Reserve. Back in 2005, Alan Greenspan referred to the surprisingly low yields as a "conundrum", meaning that it was simply not possible to explain why yields had fallen so much. Today, almost 10 years after Greenspan first used the term conundrum, the Fed Funds rate is basically at zero and 10 year Treasury bond yields only 2.55%, which means they have fallen by another 40 percent compared with the levels seen in 2005.

There have been many reasons mentioned to explain why yields are so low but the fact is that long-term yields have been in decline for almost 25 years now, so it is obvious that some very powerful changes/factors are driving this. We will try to explain this in detail here.

We believe we are witnessing a rather unique combination of different factors that keep pushing yields lower. While some of those factors are structural in nature, others are directly related to monetary policies which have become increasingly expansionary in recent years. We should simply say here that global liquidity outright exploded in recent years. So we have a situation where there are inflationary factors and deflationary tendencies at work at the same time. This makes it hard to predict the future level of inflation and with it interest rates. At the very basic, the quantity theory of money is a good equation to look at the basic factors. The Quantity theory of money states that:

MV = PQ where M stands for money supply, V stands for the velocity of money, P stands for prices and Q stands for the quantity of goods and services produced. In theory, if the money creation and the velocity of the money supply grows faster than the economy, we should see higher prices eventually. So how can it be that the money supply has grown by almost 30 percent (annually) the past few years and prices have not gone up, or at least not much in most areas? The answer can be found in the velocity factor of money which measures how fast money is moving in the economy. The chart below (taken from the St. Louis Fed web page) clearly illustrates what is happening. Velocity has tumbled from the record highs reached in the mid 90's to new lows that we have not been seeing in more than 50 years, in fact we have never seen such low levels historically.

(VELOCITY OF M2 MONEY STOCK 1958 - 2014)

While part of this fall can be explained by the unprecedented increase in the money supply, the bottom line still is that money is not flowing as quickly as it should, meaning that the newly created liquidity does not find its way into the economy because business and private households are not investing and spending as much as the did in the past (long-term average). This also confirms that what matters is not so much the price of money (which is historically low) but more the willingness to invest and spend.

Monetary policy alone would be inflationary, even highly inflationary, but there are some very powerful trends at work here that are deflationary, in some cases even strongly deflationary. For example, since the end of the 90's labor force participation rates are falling, after reaching record highs some 15 years ago. This trend will continue as baby boomers are retiring and more and more people are unable to find or unwilling to seek employment. Fewer and fewer workers need to support a growing number of people that depend on the support of income earners. So even as official statistics show a declining jobless rate, labor participation continues to fall, therefore we should take official data with a grain of salt. With more and more people unable to find employment, the number of discouraged workers is at an all time high. Also a growing number of those who can find jobs are on time contracts or even only work part-time, often with lower pay than they had in their previous jobs. Also there seems to be more uncertainty regarding the future and what it might hold for the people. This is reflected in a very strong increase in the willingness to hoard money instead of spending/investing it. In general, there is a clear tendency for the private sector to think and act more short-term and hold more cash.

This combination of factors mentioned above can't be seen as a short-term phenomena but much rather like an indication what is going to be the new normal in coming years. The economies of developed nations are all driven by the same trends and factors and those are not going to be great in the next years, maybe not for the next one or two decades. This on the other hand does not mean that things will necessarily be bad, but economic growth and interest rates are going to stay well below their long-term averages (we do not expect any meaningful increase of interest rates in the next 12-24 months which will be positive for the stock market). Remember, in an economy with low growth and deflationary factors, the premium for productive capital, meaning share prices for highly successful/profitable companies should increase not decrease. We therefore expect a further, maybe significant increase in global equity prices. These higher prices will not be primarily driven by profit growth but an increasing valuation of these profits which would imply a further increase in P/E levels in the years to come.

]]>
Mon, 06 Oct 2014 08:09:11 -0400
After rising to around 3 percent last year, the yield on 10 year U.S. Treasury bond has reversed course and recently moved as low as 2.30%. It seems like they continue to move lower toward the record low seen in 2012, when the 10 year Treasury bond yielded around 1.85%. Despite a small uptick in yields, it is rather surprising, especially considering the fact that the Federal Reserve is about to wind up its Quantitative Easing program, given the improvement in the economy and the falling unemployment rate, which currently stands at 6.1%. Interest rates are moving lower despite an improving economy? Something does not seem to be right here because normally rates should move higher as a reaction to a stronger economy and in light of a further normalization of the Fed's monetary policy. What is pushing yields down and what do the lower rates means for the outlook of the economy? We try to analyze this and give some answer to the new but old interest rates "conundrum".

In 1996, the former Federal Reserve chairman Alan Greenspan used the term "irrational exuberance" to describe what he believed was a stock market bubble. He simply couldn't explain the rather rapid increase in equity prices seen in the early 90's. Only very few people back at that time would have thought that equity markets were nowhere near their top, they continued to climb for another three years before their sharp correction early in the new millennium. Between 1998 and 2000, the Fed Funds rate rose from around 4 percent to 6.5 percent before the stock market started a large correction and the economy began to slow as all the hype and enthusiasm about the new age of technological revolution began to fade. In order to support the economy, the Federal Reserve began to lower interest rates and within less than 2 years (!!), the Fed Funds rate fell below 2 percent and eventually bottomed out at 1.5% in 2003/2004. The yield on 10 year Treasury bonds had fallen to around 4 percent which even surprised the Federal Reserve. Back in 2005, Alan Greenspan referred to the surprisingly low yields as a "conundrum", meaning that it was simply not possible to explain why yields had fallen so much. Today, almost 10 years after Greenspan first used the term conundrum, the Fed Funds rate is basically at zero and 10 year Treasury bond yields only 2.55%, which means they have fallen by another 40 percent compared with the levels seen in 2005.

There have been many reasons mentioned to explain why yields are so low but the fact is that long-term yields have been in decline for almost 25 years now, so it is obvious that some very powerful changes/factors are driving this. We will try to explain this in detail here.

We believe we are witnessing a rather unique combination of different factors that keep pushing yields lower. While some of those factors are structural in nature, others are directly related to monetary policies which have become increasingly expansionary in recent years. We should simply say here that global liquidity outright exploded in recent years. So we have a situation where there are inflationary factors and deflationary tendencies at work at the same time. This makes it hard to predict the future level of inflation and with it interest rates. At the very basic, the quantity theory of money is a good equation to look at the basic factors. The Quantity theory of money states that:

MV = PQ where M stands for money supply, V stands for the velocity of money, P stands for prices and Q stands for the quantity of goods and services produced. In theory, if the money creation and the velocity of the money supply grows faster than the economy, we should see higher prices eventually. So how can it be that the money supply has grown by almost 30 percent (annually) the past few years and prices have not gone up, or at least not much in most areas? The answer can be found in the velocity factor of money which measures how fast money is moving in the economy. The chart below (taken from the St. Louis Fed web page) clearly illustrates what is happening. Velocity has tumbled from the record highs reached in the mid 90's to new lows that we have not been seeing in more than 50 years, in fact we have never seen such low levels historically.

(VELOCITY OF M2 MONEY STOCK 1958 - 2014)

While part of this fall can be explained by the unprecedented increase in the money supply, the bottom line still is that money is not flowing as quickly as it should, meaning that the newly created liquidity does not find its way into the economy because business and private households are not investing and spending as much as the did in the past (long-term average). This also confirms that what matters is not so much the price of money (which is historically low) but more the willingness to invest and spend.

Monetary policy alone would be inflationary, even highly inflationary, but there are some very powerful trends at work here that are deflationary, in some cases even strongly deflationary. For example, since the end of the 90's labor force participation rates are falling, after reaching record highs some 15 years ago. This trend will continue as baby boomers are retiring and more and more people are unable to find or unwilling to seek employment. Fewer and fewer workers need to support a growing number of people that depend on the support of income earners. So even as official statistics show a declining jobless rate, labor participation continues to fall, therefore we should take official data with a grain of salt. With more and more people unable to find employment, the number of discouraged workers is at an all time high. Also a growing number of those who can find jobs are on time contracts or even only work part-time, often with lower pay than they had in their previous jobs. Also there seems to be more uncertainty regarding the future and what it might hold for the people. This is reflected in a very strong increase in the willingness to hoard money instead of spending/investing it. In general, there is a clear tendency for the private sector to think and act more short-term and hold more cash.

This combination of factors mentioned above can't be seen as a short-term phenomena but much rather like an indication what is going to be the new normal in coming years. The economies of developed nations are all driven by the same trends and factors and those are not going to be great in the next years, maybe not for the next one or two decades. This on the other hand does not mean that things will necessarily be bad, but economic growth and interest rates are going to stay well below their long-term averages (we do not expect any meaningful increase of interest rates in the next 12-24 months which will be positive for the stock market). Remember, in an economy with low growth and deflationary factors, the premium for productive capital, meaning share prices for highly successful/profitable companies should increase not decrease. We therefore expect a further, maybe significant increase in global equity prices. These higher prices will not be primarily driven by profit growth but an increasing valuation of these profits which would imply a further increase in P/E levels in the years to come.

]]>
Global Macroeconomics / Staying Competitive In A World Of Moderate Growthhttp://seekingalpha.com/instablog/324650-daniel-zurbrugg/3332845-global-macroeconomics-staying-competitive-in-a-world-of-moderate-growth?source=feed
3332845
Despite record low interest rates in most major economies, global GDP growth has remained subdued and significantly below the historical averages. The GDP forecast for 2014 needed to be adjusted several times this year and it now looks like global growth is just under 3 percent. The outlook for 2015 is slightly more positive but even with growth accelerating towards 3.5%, it is still low compared to historical numbers. So the obvious questions are: when will we return to the historical averages for GDP growth? Is there a chance that we might not see such growth rates anymore?

Looking at the major economies shows one common characteristic. When GDP growth rates are adjusted for the rate of inflation, the results show that very few economies are experiencing real economic growth. While inflation in the U.S. is close to 2% (based on the official statistics), inflation in Europe and Japan are lower, in fact they are close to zero. Despite a lot of economic stimulus and low interest rates, we have not seen a pick up in real economic activity. This fact is confirmed by a number of other economic statistics such as the velocity of the money flow. Central banks around the world have done what they could, in fact they might have done more than they should have, but going forward, economic growth needs to come from structural reforms, increasing productivity and a reawakening of "animal spirits". To give you the answer upfront, it is going to be very hard to achieve this, but it is not impossible. However, it looks like we might need to redefine what we understand as reasonable in terms of long-term economic growth.

Today's situation is such that central banks are concerned about deflationary pressures, which is understandable looking at the lacklustre growth dynamic in most major economies. In the next couple of years, central bank will focus on fighting deflation much more rather than worrying about inflation. In addition to that, countries need to make changes and adopt policies that will promote economic growth. This will be harder in Europe and Japan but the growing pressure will eventually force change; countries will not be left with any other alternatives. This increasing pressure is also being reinforced by structural changes such as an aging population. This means that the most likely scenario for the coming months and years is that global growth will recover but at a rate that is going to be too slow to help solving important issues such as the high unemployment rate in Europe and the U.S. or the increasingly difficult situation for pension systems. Pensions systems in most countries are based on unrealistic assumptions about growth and investment returns. During times of higher, actually significantly higher rates, it was easy to achieve investment returns of 5 percent when the yields on government bonds were already close to the number but today is a whole different game.

This environment with anaemic growth in the developed world and deflationary pressure will continue to keep interest rates at very low levels, this in turn will make it easier for countries in emerging markets which are still more dependent on financing in U.S. Dollar, Euro or Yen. This will help and support growth in emerging markets and we expect that the contribution to global growth coming from emerging markets will go even higher. Today already, around 70% of GDP growth comes from emerging market countries.

For countries in the developed world, the main goal will be to become more productive and competitive. Some of these countries are already on a very high level but others have a lot of catching up to do. The World Economic Forum (WEF) recently published its 2014 "Global Competitiveness Report" and a look at it reveals some highly interesting details. For the 7th year in a row, Switzerland has ranked no. 1 and is the world's most competitive economy. There are several reasons for this but clearly Switzerland has always remained a very "open" economy with strong business ties internationally. Also, Switzerland's economy is well diversified among a number of sectors and not just dependent on one or two major sectors. Singapore has remained no. 2 in this global ranking, closely followed by the U.S., Finland and Germany. Even more interesting is a quick look at some large countries that are not found in the top group. Italy, for example, is only ranked no. 49 in the world, Spain a little bit better at no. 35 and finally Greece, ranked no. 91 and way behind their European peers.

The report is highly interesting as the study defines competitiveness as the set of institutions, policies and factors that determine the level of productivity. Clearly, there is a close correlation between the ranking and the level of GDP per capita in each country. But also several other factors were taken into consideration and it might be worth some time to have a detailed look at this report that can be found under the following link:

]]>
Mon, 06 Oct 2014 08:07:12 -0400
Despite record low interest rates in most major economies, global GDP growth has remained subdued and significantly below the historical averages. The GDP forecast for 2014 needed to be adjusted several times this year and it now looks like global growth is just under 3 percent. The outlook for 2015 is slightly more positive but even with growth accelerating towards 3.5%, it is still low compared to historical numbers. So the obvious questions are: when will we return to the historical averages for GDP growth? Is there a chance that we might not see such growth rates anymore?

Looking at the major economies shows one common characteristic. When GDP growth rates are adjusted for the rate of inflation, the results show that very few economies are experiencing real economic growth. While inflation in the U.S. is close to 2% (based on the official statistics), inflation in Europe and Japan are lower, in fact they are close to zero. Despite a lot of economic stimulus and low interest rates, we have not seen a pick up in real economic activity. This fact is confirmed by a number of other economic statistics such as the velocity of the money flow. Central banks around the world have done what they could, in fact they might have done more than they should have, but going forward, economic growth needs to come from structural reforms, increasing productivity and a reawakening of "animal spirits". To give you the answer upfront, it is going to be very hard to achieve this, but it is not impossible. However, it looks like we might need to redefine what we understand as reasonable in terms of long-term economic growth.

Today's situation is such that central banks are concerned about deflationary pressures, which is understandable looking at the lacklustre growth dynamic in most major economies. In the next couple of years, central bank will focus on fighting deflation much more rather than worrying about inflation. In addition to that, countries need to make changes and adopt policies that will promote economic growth. This will be harder in Europe and Japan but the growing pressure will eventually force change; countries will not be left with any other alternatives. This increasing pressure is also being reinforced by structural changes such as an aging population. This means that the most likely scenario for the coming months and years is that global growth will recover but at a rate that is going to be too slow to help solving important issues such as the high unemployment rate in Europe and the U.S. or the increasingly difficult situation for pension systems. Pensions systems in most countries are based on unrealistic assumptions about growth and investment returns. During times of higher, actually significantly higher rates, it was easy to achieve investment returns of 5 percent when the yields on government bonds were already close to the number but today is a whole different game.

This environment with anaemic growth in the developed world and deflationary pressure will continue to keep interest rates at very low levels, this in turn will make it easier for countries in emerging markets which are still more dependent on financing in U.S. Dollar, Euro or Yen. This will help and support growth in emerging markets and we expect that the contribution to global growth coming from emerging markets will go even higher. Today already, around 70% of GDP growth comes from emerging market countries.

For countries in the developed world, the main goal will be to become more productive and competitive. Some of these countries are already on a very high level but others have a lot of catching up to do. The World Economic Forum (WEF) recently published its 2014 "Global Competitiveness Report" and a look at it reveals some highly interesting details. For the 7th year in a row, Switzerland has ranked no. 1 and is the world's most competitive economy. There are several reasons for this but clearly Switzerland has always remained a very "open" economy with strong business ties internationally. Also, Switzerland's economy is well diversified among a number of sectors and not just dependent on one or two major sectors. Singapore has remained no. 2 in this global ranking, closely followed by the U.S., Finland and Germany. Even more interesting is a quick look at some large countries that are not found in the top group. Italy, for example, is only ranked no. 49 in the world, Spain a little bit better at no. 35 and finally Greece, ranked no. 91 and way behind their European peers.

The report is highly interesting as the study defines competitiveness as the set of institutions, policies and factors that determine the level of productivity. Clearly, there is a close correlation between the ranking and the level of GDP per capita in each country. But also several other factors were taken into consideration and it might be worth some time to have a detailed look at this report that can be found under the following link:

]]>
The Investment World Five Years From Nowhttp://seekingalpha.com/instablog/324650-daniel-zurbrugg/3332815-the-investment-world-five-years-from-now?source=feed
3332815
A key principle for long-term success in investments is to identify large trends and changes in the economy and look at current developments in economics and politics and see how they fit into the bigger picture. Recent geopolitical events certainly make one feel like we are moving backwards in time; the recent problems between Russia and the western world clearly illustrates that. Also, new conflicts in Iraq and Syria created renewed tension in a region that was thought to have the worst behind it but where it seems like it is impossible to make real progress. A similar trend can be observed in the investment world. After two decades of rapid change and globalization, the last two years were different. Sovereign debt problems, aggressive monetary policies and lower global economic growth caused global capital flows to reverse somewhat and as a direct consequence, the U.S. Dollar could gain ground versus major currencies despite its many fundamental problems. Is the U.S. Dollar about to start a comeback or is it just a short-term bounce in a long-term downward trend? The answer to this question depends on the future development of global capital markets. What are the chances of global capital markets becoming more global again in the coming years? In our view, while we are witnessing a short-term situation that has pushed up the U.S. Dollar, over the next couple of years, the role of the U.S. Dollar in the global financial system will diminish further.

Global growth has remained low and has only slightly improved from last year. For next year we see some further improvement but the pace of economic recovery will remain sluggish. Looking at current GDP expansion in the three major economies (U.S., Europe, Japan) shows that growth levels are well below the long-term average. At first glance, the U.S. looks like it is ahead a bit with GDP expanding at around 2.2%, however, adjusted for the rate of inflation, real economic growth is disappointing in pretty much every developed country. Regular readers of our commentaries know that we have talked about this global situation of low growth a number of times in the past few years, trying to explain the factors that are causing this. We are referring to it as the "New Normal" in global economics and argue that the headwinds for global growth are mainly based on structural changes that are impossible to correct short- and medium term.

The dominant structural driver is the rapidly changing demographics and in particular the aging of the developed world. The influence from this powerful trend has only just started in the last few years and its impact will be felt for the next 20 to 30 years. This will change the structure of every major economy on this planet and governments will have to find new solutions to deal with the problems being caused by these structural factors. This will, for example, lead to a complete change over of pension systems, especially public pension schemes, where a declining number of younger workers is financing an ever larger and larger number of retirees. This will lead to tensions and eventually reforms in public pension systems across the globe.

Governments will find it harder and harder to find good compromises, especially as their own financial situation remains very difficult. Many governments these days deal with enormous amounts of sovereign debt and these governments will find it increasingly difficult to service that debt. In light of this, it seems rather hard to believe that interest rates in major markets are going to rise in any meaningful way in the coming 2-3 years. The fact that the yields for sovereign bonds for most major countries have been declining since the beginning of the year is a clear indication what the market expects.

While it is one thing to speculate about a few possible scenarios for the future, making actual investment decisions is a lot harder and it is essential to have a longer term view and see how things develop in the long-run. Making good investments in the long-run is the backbone of every successful investment strategy, so time is an essential component of good performance results. The world and especially the investment world will look quite a bit different five and ten years from now.

After another 1-2 years of low global growth, we believe, we are going to see stronger economic momentum but we do not expect major economies to return to the high growth rates seen historically. Eventually higher inflation will show up as the vast amount of global liquidity will finally find its way into the real economy. Interest rates are starting to go up but probably not as much as they should given the levels of inflation. This would mean that debt would be monetized and the purchasing power of money further destroyed. Stronger growth, still low enough levels of interest rates and a lot of pent up demand for capital investments and consumption would create an almost perfect environment for global equity markets. Also these factors should eventually result in a strong upward move in precious metals and other hard assets and commodities. Of course, the impact on bond markets would be negative, but we can't see an actual crash of the bond market, simply because interest rates will only go up slowly.

Despite today's valuation of equity markets, we believe there is a lot more return potential in the coming years. Partially driven by higher corporate earnings and partially driven by the fact that there are not going to be a lot of investment alternatives. Many companies today find themselves in a very lean and cash rich position, they will be able to generate rapidly growing profits even if there is only a small improvement in economic growth. Productive assets, such as stocks of well managed firms, are going to be something very scarce in a world of lower (by long-term historical standards) growth, they should therefore trade at a premium and that speaks for further expansion of today's multiples.

Successful long-term investing requires a well defined strategy and the discipline to execute on a long-term plan even in times when financial markets make it difficult to generate positive investment performance. In the coming years, there will be plenty of highly lucrative investment opportunities even if the overall economic momentum remains below the historical averages. The outlook for a long period of low interest rates will require investors globally to switch to equities for long-term capital appreciation.

]]>
Mon, 06 Oct 2014 08:01:23 -0400
A key principle for long-term success in investments is to identify large trends and changes in the economy and look at current developments in economics and politics and see how they fit into the bigger picture. Recent geopolitical events certainly make one feel like we are moving backwards in time; the recent problems between Russia and the western world clearly illustrates that. Also, new conflicts in Iraq and Syria created renewed tension in a region that was thought to have the worst behind it but where it seems like it is impossible to make real progress. A similar trend can be observed in the investment world. After two decades of rapid change and globalization, the last two years were different. Sovereign debt problems, aggressive monetary policies and lower global economic growth caused global capital flows to reverse somewhat and as a direct consequence, the U.S. Dollar could gain ground versus major currencies despite its many fundamental problems. Is the U.S. Dollar about to start a comeback or is it just a short-term bounce in a long-term downward trend? The answer to this question depends on the future development of global capital markets. What are the chances of global capital markets becoming more global again in the coming years? In our view, while we are witnessing a short-term situation that has pushed up the U.S. Dollar, over the next couple of years, the role of the U.S. Dollar in the global financial system will diminish further.

Global growth has remained low and has only slightly improved from last year. For next year we see some further improvement but the pace of economic recovery will remain sluggish. Looking at current GDP expansion in the three major economies (U.S., Europe, Japan) shows that growth levels are well below the long-term average. At first glance, the U.S. looks like it is ahead a bit with GDP expanding at around 2.2%, however, adjusted for the rate of inflation, real economic growth is disappointing in pretty much every developed country. Regular readers of our commentaries know that we have talked about this global situation of low growth a number of times in the past few years, trying to explain the factors that are causing this. We are referring to it as the "New Normal" in global economics and argue that the headwinds for global growth are mainly based on structural changes that are impossible to correct short- and medium term.

The dominant structural driver is the rapidly changing demographics and in particular the aging of the developed world. The influence from this powerful trend has only just started in the last few years and its impact will be felt for the next 20 to 30 years. This will change the structure of every major economy on this planet and governments will have to find new solutions to deal with the problems being caused by these structural factors. This will, for example, lead to a complete change over of pension systems, especially public pension schemes, where a declining number of younger workers is financing an ever larger and larger number of retirees. This will lead to tensions and eventually reforms in public pension systems across the globe.

Governments will find it harder and harder to find good compromises, especially as their own financial situation remains very difficult. Many governments these days deal with enormous amounts of sovereign debt and these governments will find it increasingly difficult to service that debt. In light of this, it seems rather hard to believe that interest rates in major markets are going to rise in any meaningful way in the coming 2-3 years. The fact that the yields for sovereign bonds for most major countries have been declining since the beginning of the year is a clear indication what the market expects.

While it is one thing to speculate about a few possible scenarios for the future, making actual investment decisions is a lot harder and it is essential to have a longer term view and see how things develop in the long-run. Making good investments in the long-run is the backbone of every successful investment strategy, so time is an essential component of good performance results. The world and especially the investment world will look quite a bit different five and ten years from now.

After another 1-2 years of low global growth, we believe, we are going to see stronger economic momentum but we do not expect major economies to return to the high growth rates seen historically. Eventually higher inflation will show up as the vast amount of global liquidity will finally find its way into the real economy. Interest rates are starting to go up but probably not as much as they should given the levels of inflation. This would mean that debt would be monetized and the purchasing power of money further destroyed. Stronger growth, still low enough levels of interest rates and a lot of pent up demand for capital investments and consumption would create an almost perfect environment for global equity markets. Also these factors should eventually result in a strong upward move in precious metals and other hard assets and commodities. Of course, the impact on bond markets would be negative, but we can't see an actual crash of the bond market, simply because interest rates will only go up slowly.

Despite today's valuation of equity markets, we believe there is a lot more return potential in the coming years. Partially driven by higher corporate earnings and partially driven by the fact that there are not going to be a lot of investment alternatives. Many companies today find themselves in a very lean and cash rich position, they will be able to generate rapidly growing profits even if there is only a small improvement in economic growth. Productive assets, such as stocks of well managed firms, are going to be something very scarce in a world of lower (by long-term historical standards) growth, they should therefore trade at a premium and that speaks for further expansion of today's multiples.

Successful long-term investing requires a well defined strategy and the discipline to execute on a long-term plan even in times when financial markets make it difficult to generate positive investment performance. In the coming years, there will be plenty of highly lucrative investment opportunities even if the overall economic momentum remains below the historical averages. The outlook for a long period of low interest rates will require investors globally to switch to equities for long-term capital appreciation.

]]>
Global MacroStay Tuned For The Release Of Our Latest Investment Update (To Be Released October 6. 2014http://seekingalpha.com/instablog/324650-daniel-zurbrugg/3323335-stay-tuned-for-the-release-of-our-latest-investment-update-to-be-released-october-6-2014?source=feed
3323335
also please sign up for it directly at: info@swissinfinity.ch

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GLOBAL MACRO - THE BIG REBALANCINGhttp://seekingalpha.com/instablog/324650-daniel-zurbrugg/2145612-global-macro-the-big-rebalancing?source=feed
2145612
The sovereign debt crisis has been the main headache of global financial markets for the past two years and hardly a week passed by without more news regarding the financial problems of Greece, Portugal, Spain or the U.S., just to name a few. Still today, many fear that a debt related financial and economic collapse is on the horizon. The popular argument is always the same: Too much debt.

We remain concerned about the debt problems of many nations and believe that it will take several years to improve this situation. However, in our view, the current discussion is too much focused on the debt side of the equation. Yes, too much debt is not good, but what makes it even worse is when there are no assets and income to cover and support the debt. In that sense, looking at a country is not much different from reviewing a company and analyzing its financials; just what financial analysts do the whole day. Interestingly, in the discussion about sovereign debt the comparison between nations is often done based on an overly simplistic view. There is one aspect of the comparison that is a lot different when reviewing the financial standings of a nation. Unlike a private company, a nation with its own central bank can determine the value of its currency by "printing" more money if needed. This is for example the case in the U.S. where the Federal Reserve has been engaging in a large scale asset purchase plan (quantitative easing). Skeptics often refer to this as "printing money out of thin air" and they see this as a first step towards high inflation, possibly even hyper-inflation. This is not wrong, but also not fully correct. It depends what the newly created liquidity does and if it finds its way into the real economy. What we are seeing in today's situation is that most of that new liquidity isn't doing much at all, the main effect has been that the banks deposit more money back at the central banks. This in turn is helping the banks to earn risk-free profits so they don't have to actually lend money to somebody which would actually increase the risk for the banks. Since the actual money flow is not increased, the risk for inflation is well contained and as long as there is not a real pick up for credit from households and businesses, it is very unlikely that we see a sharp spike in yields in most major economies. Despite some encouraging signs in recent weeks the actual velocity of the money flow remains very slow. Velocity is an indication of the speed at which money is flowing in the financial system. Increasing velocity is an indication of improving economic activity, something that has not really happened so far. Also, given the fact that commodity prices have fallen sharply in the past months (see chart "Commodity prices" below), the risk of seeing a sharp increase in inflation is almost zero.

The chart above clearly shows the slowing growth momentum that is currently seen in most major economies. Slower growth has direct implications on the commodity market where prices have moved sharply lower in the recent past. Charts from BIS

Actually, the risk of seeing negative inflation rates in many economies is significantly higher. Central banks see this and since most of them fear deflationary tendencies, they will all keep loose monetary policies. In a global context it does not even make much of a difference if the U.S. Federal Reserve is going to reduce its asset purchase program eventually. Other central banks, especially the Bank of Japan, have already started to make up for that. "QQE", quantitative and qualitative monetary easing as the Japanese program is called is even more aggressive than the Fed's program. It aims to almost double the monetary base within the next two years (!!) and buy back bonds and other securities on a very large scale. The goal is to reduce yields across the whole yield curve, especially at the longer end and by doing so to encourage consumption and investments. What is different with the program in Japan is that the government is also planning to increase investments, this in sharp contrast to the U.S. and Europe where governments are actually cutting back their spending.

The charts above show the effects of central bank intervention and how this impacts interest rates, despite a small increase in the last couple of weeks, interest rates in many markets are still near record lows, with expected increases not coming before mid 2014

It remains to be seen which is the better way and for different countries different strategies might be right. Japan has very high levels of debt but it also has a high level of domestic savings, so it looks like this is sustainable. In the U.S. the situation is slightly different due to the lower savings rate. Just cutting spending is not going to solve the problem. What is needed are public investments that make sense and that have real economic returns. So the discussion should be which strategy is appropriate for a given country. With regards to Japan and the U.S. there needs to be a more forward thinking strategy. For the European countries, this is a slightly more challenging issue. Countries such as Italy, Spain or Greece are not poor countries, actually these governments own some very valuable assets, the problem is that those countries need to make more reforms and increase privatization of state owned assets and this is something that is much harder to do in Europe. Reforms take time and they are usually only done under pressure; the liberalization of the job market in Europe is a good example of that. However, the current economic situation is creating the pressure needed to jump start reforms.

Monetary and fiscal policies are also impacting financial markets, especially stock markets. Lower yields typically increase the present value of stock investments, but this is only one influence. Equity prices also react to interest rates because the lower these rates are the less attractive the bond market is and the more attractive equities are on a relative basis. The chart below illustrates this very clearly. Stocks have been doing much better than other investments (such as bonds and commodities). We expect interest rates are going to remain supportive for stocks for quite some time to come. Yields might go up slightly but on a relative basis they still remain exceptionally low.

Low interest rates are making equity investments more attractive on a relative basis again. With yields remaining low for longer, the chances for a continuing outperformance of stocks versus bonds and precious metals seems very likely

We regard the current discussion and speculation about when the Federal Reserve is going to stop its asset purchase program as a non event. In our view it makes no difference and it is not changing the fact that rates are going to remain at very low levels. A sudden and sharp increase in yields would put the current, already fragile, recovery at risk. Also other markets are going to see very low interest rates for probably years to come. For many central banks price stability is not a very important goal anymore as other measures such as GDP growth or employment numbers are the main focus.

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Tue, 20 Aug 2013 04:54:44 -0400
The sovereign debt crisis has been the main headache of global financial markets for the past two years and hardly a week passed by without more news regarding the financial problems of Greece, Portugal, Spain or the U.S., just to name a few. Still today, many fear that a debt related financial and economic collapse is on the horizon. The popular argument is always the same: Too much debt.

We remain concerned about the debt problems of many nations and believe that it will take several years to improve this situation. However, in our view, the current discussion is too much focused on the debt side of the equation. Yes, too much debt is not good, but what makes it even worse is when there are no assets and income to cover and support the debt. In that sense, looking at a country is not much different from reviewing a company and analyzing its financials; just what financial analysts do the whole day. Interestingly, in the discussion about sovereign debt the comparison between nations is often done based on an overly simplistic view. There is one aspect of the comparison that is a lot different when reviewing the financial standings of a nation. Unlike a private company, a nation with its own central bank can determine the value of its currency by "printing" more money if needed. This is for example the case in the U.S. where the Federal Reserve has been engaging in a large scale asset purchase plan (quantitative easing). Skeptics often refer to this as "printing money out of thin air" and they see this as a first step towards high inflation, possibly even hyper-inflation. This is not wrong, but also not fully correct. It depends what the newly created liquidity does and if it finds its way into the real economy. What we are seeing in today's situation is that most of that new liquidity isn't doing much at all, the main effect has been that the banks deposit more money back at the central banks. This in turn is helping the banks to earn risk-free profits so they don't have to actually lend money to somebody which would actually increase the risk for the banks. Since the actual money flow is not increased, the risk for inflation is well contained and as long as there is not a real pick up for credit from households and businesses, it is very unlikely that we see a sharp spike in yields in most major economies. Despite some encouraging signs in recent weeks the actual velocity of the money flow remains very slow. Velocity is an indication of the speed at which money is flowing in the financial system. Increasing velocity is an indication of improving economic activity, something that has not really happened so far. Also, given the fact that commodity prices have fallen sharply in the past months (see chart "Commodity prices" below), the risk of seeing a sharp increase in inflation is almost zero.

The chart above clearly shows the slowing growth momentum that is currently seen in most major economies. Slower growth has direct implications on the commodity market where prices have moved sharply lower in the recent past. Charts from BIS

Actually, the risk of seeing negative inflation rates in many economies is significantly higher. Central banks see this and since most of them fear deflationary tendencies, they will all keep loose monetary policies. In a global context it does not even make much of a difference if the U.S. Federal Reserve is going to reduce its asset purchase program eventually. Other central banks, especially the Bank of Japan, have already started to make up for that. "QQE", quantitative and qualitative monetary easing as the Japanese program is called is even more aggressive than the Fed's program. It aims to almost double the monetary base within the next two years (!!) and buy back bonds and other securities on a very large scale. The goal is to reduce yields across the whole yield curve, especially at the longer end and by doing so to encourage consumption and investments. What is different with the program in Japan is that the government is also planning to increase investments, this in sharp contrast to the U.S. and Europe where governments are actually cutting back their spending.

The charts above show the effects of central bank intervention and how this impacts interest rates, despite a small increase in the last couple of weeks, interest rates in many markets are still near record lows, with expected increases not coming before mid 2014

It remains to be seen which is the better way and for different countries different strategies might be right. Japan has very high levels of debt but it also has a high level of domestic savings, so it looks like this is sustainable. In the U.S. the situation is slightly different due to the lower savings rate. Just cutting spending is not going to solve the problem. What is needed are public investments that make sense and that have real economic returns. So the discussion should be which strategy is appropriate for a given country. With regards to Japan and the U.S. there needs to be a more forward thinking strategy. For the European countries, this is a slightly more challenging issue. Countries such as Italy, Spain or Greece are not poor countries, actually these governments own some very valuable assets, the problem is that those countries need to make more reforms and increase privatization of state owned assets and this is something that is much harder to do in Europe. Reforms take time and they are usually only done under pressure; the liberalization of the job market in Europe is a good example of that. However, the current economic situation is creating the pressure needed to jump start reforms.

Monetary and fiscal policies are also impacting financial markets, especially stock markets. Lower yields typically increase the present value of stock investments, but this is only one influence. Equity prices also react to interest rates because the lower these rates are the less attractive the bond market is and the more attractive equities are on a relative basis. The chart below illustrates this very clearly. Stocks have been doing much better than other investments (such as bonds and commodities). We expect interest rates are going to remain supportive for stocks for quite some time to come. Yields might go up slightly but on a relative basis they still remain exceptionally low.

Low interest rates are making equity investments more attractive on a relative basis again. With yields remaining low for longer, the chances for a continuing outperformance of stocks versus bonds and precious metals seems very likely

We regard the current discussion and speculation about when the Federal Reserve is going to stop its asset purchase program as a non event. In our view it makes no difference and it is not changing the fact that rates are going to remain at very low levels. A sudden and sharp increase in yields would put the current, already fragile, recovery at risk. Also other markets are going to see very low interest rates for probably years to come. For many central banks price stability is not a very important goal anymore as other measures such as GDP growth or employment numbers are the main focus.

The good news first: Global GDP continues to recover and is projected to be around 3.5% for 2013 and about 4.1% for 2014 according to the latest estimates. However, advanced economies continue to experience little to no economic growth which is going to have an impact on the job market in those countries. We believe that this is not going to improve much in the coming months and think it will take at least another 6-12 months before we are starting to see increased hiring activity. The recent U.S. Jobs Report for February, which showed a gain of 236'000 jobs (forecasted 165'000) came as a big surprise to many and the market reacted positively to the news. We feel that the jobs report needs to be put in the right context in order to see how good or bad things are. We have often argued that it is not so much about the headline numbers but much more about the quality of the jobs being created. Looking deeper, these numbers tell a different story. Since 2008, the U.S. lost about 8.9mln jobs and since the end of 2009 the economy only created 5.7mln new jobs. So if the job creation continues at the same speed, it will take another two years or so just to get back to the levels prior to the recession of 2008. What is even more disturbing is the fact that the jobs being created are not of the same quality as the jobs that were lost. Also, more and more people only work part time; while a changing lifestyle might explain some of that, most people simply can't find full time employment anymore. (We also need to mention here that in the meantime the preliminary job numbers for March came in much weaker than anticipated). The situation in other countries, for example Spain and Italy, is similar or even worse. Young people in particular are struggling to find jobs. This in turn is creating serious social economic problems. The worsening job situation will continue to force structural reforms intended to liberalize the job market which will hopefully change things to the better, but we can't see much of an improvement in the next 12-18 months.

While the outlook for developed countries remains weak, growth in emerging economies is accelerating with GDP in those regions growing by about 5.5% in 2013 and 5.9% next year. This is encouraging and we expect the improving growth momentum of emerging markets to have a positive impact on developed economies eventually. The improving business conditions in emerging economies are especially visible in the earnings numbers of large companies operating globally.

Global equity markets seem to already anticipate the improving outlook and have started to rise since the fourth quarter of last year. There are a number of reasons for the recent positive developments of equity markets. While the overall improving economic outlook is clearly helpful, the lack of investment alternatives has been another important reason for the surge of equity prices. In a world of record low interest rates, the bond markets are not a real alternative. Other investments such as precious metals have also become less attractive on a relative basis considering the steep outperformance in the last decade. With fair valuations, good dividend yields and the outlook for improving corporate profits, global equities are again a very attractive place for investors. The chart below shows the strong performance of global equity markets in recent months, with the chart on the right hand side showing the declining volatility of markets, another sign that some of the negative pressure is gone. So in short, there is a compelling combination of various factors that have driven equity markets in recent months and the outlook for the next 12-18 months doesn't seem to be very different.

Explaining the recent surge in equity markets is therefore relatively easy but for long-term investors the main question is whether this outperformance has a chance to continue for a longer period of time. We even ask the question: Could there be a structural bull market for equities coming? Considering the huge market challenges we had in recent years, this question seems a bit over ambitious. There are, however, some interesting points to think about. Historically, interest rates have followed a 30 year cycle from peak to trough. In this last cycle, interest rates peaked in the early 80's and have since then trended lower and since yields are now close to zero, it seems realistic that we are nearing another turning point. Stock market cycles are usually shorter than that of bond markets, typically 15 to 20 years. Stock markets have gone nowhere since the peak in 2000 so it also seems realistic to assume that this cycle seems to be in a mature state.

So is it possible that the recent surge in stock prices is the start of a longer-term bull market? Eventually central banks have to normalize monetary policies and there will be less cheap money flowing into markets. Many fear that once this starts to happen, equity prices are going to drop significantly. Again, looking at history, this concern doesn't seem justified. Actually, the opposite is true. Turning points in interest rate cycles have normally also been turning points for equity markets and rising yields do not cause a selloff in equities. This means that in coming years we could see the current spike in equity prices turn into a structural bull market for equities, even if central banks eventually start to hike rates.

Another indication that the pressure is easing - falling bond yields/increased refinancing

Higher interest rates are not always a bad sign for an economy and as long as the increase takes places over a certain period of time, higher rates are not necessarily triggering a selloff in equity prices. While interest rates remain low in many parts of the world, we believe that yields are slowly starting to turn around. Over a time frame of 12-18 months we see a continuing normalization of interest rates, higher economic activity and renewed growth momentum in corporate profits.

What are the risk factors that could bring back renewed, negative market volatility? A few come to mind, but we think that neither the European debt crisis nor the U.S. deficit story are changing things in a meaningful way. We are more concerned about geopolitical events such as the situation with North Korea or Iran. Especially close we are watching the situation with North Korea with great concern. While the recent actions by the North Korean regime have failed to impact markets negatively, the risk in our view is that a small event or accident could trigger military actions from North and/or South Korea. Such an event could further destabilize the region and cause enormous uncertainty among financial markets worldwide. For now, we still think this is a low probability event but it needs to be monitored very carefully.

The good news first: Global GDP continues to recover and is projected to be around 3.5% for 2013 and about 4.1% for 2014 according to the latest estimates. However, advanced economies continue to experience little to no economic growth which is going to have an impact on the job market in those countries. We believe that this is not going to improve much in the coming months and think it will take at least another 6-12 months before we are starting to see increased hiring activity. The recent U.S. Jobs Report for February, which showed a gain of 236'000 jobs (forecasted 165'000) came as a big surprise to many and the market reacted positively to the news. We feel that the jobs report needs to be put in the right context in order to see how good or bad things are. We have often argued that it is not so much about the headline numbers but much more about the quality of the jobs being created. Looking deeper, these numbers tell a different story. Since 2008, the U.S. lost about 8.9mln jobs and since the end of 2009 the economy only created 5.7mln new jobs. So if the job creation continues at the same speed, it will take another two years or so just to get back to the levels prior to the recession of 2008. What is even more disturbing is the fact that the jobs being created are not of the same quality as the jobs that were lost. Also, more and more people only work part time; while a changing lifestyle might explain some of that, most people simply can't find full time employment anymore. (We also need to mention here that in the meantime the preliminary job numbers for March came in much weaker than anticipated). The situation in other countries, for example Spain and Italy, is similar or even worse. Young people in particular are struggling to find jobs. This in turn is creating serious social economic problems. The worsening job situation will continue to force structural reforms intended to liberalize the job market which will hopefully change things to the better, but we can't see much of an improvement in the next 12-18 months.

While the outlook for developed countries remains weak, growth in emerging economies is accelerating with GDP in those regions growing by about 5.5% in 2013 and 5.9% next year. This is encouraging and we expect the improving growth momentum of emerging markets to have a positive impact on developed economies eventually. The improving business conditions in emerging economies are especially visible in the earnings numbers of large companies operating globally.

Global equity markets seem to already anticipate the improving outlook and have started to rise since the fourth quarter of last year. There are a number of reasons for the recent positive developments of equity markets. While the overall improving economic outlook is clearly helpful, the lack of investment alternatives has been another important reason for the surge of equity prices. In a world of record low interest rates, the bond markets are not a real alternative. Other investments such as precious metals have also become less attractive on a relative basis considering the steep outperformance in the last decade. With fair valuations, good dividend yields and the outlook for improving corporate profits, global equities are again a very attractive place for investors. The chart below shows the strong performance of global equity markets in recent months, with the chart on the right hand side showing the declining volatility of markets, another sign that some of the negative pressure is gone. So in short, there is a compelling combination of various factors that have driven equity markets in recent months and the outlook for the next 12-18 months doesn't seem to be very different.

Explaining the recent surge in equity markets is therefore relatively easy but for long-term investors the main question is whether this outperformance has a chance to continue for a longer period of time. We even ask the question: Could there be a structural bull market for equities coming? Considering the huge market challenges we had in recent years, this question seems a bit over ambitious. There are, however, some interesting points to think about. Historically, interest rates have followed a 30 year cycle from peak to trough. In this last cycle, interest rates peaked in the early 80's and have since then trended lower and since yields are now close to zero, it seems realistic that we are nearing another turning point. Stock market cycles are usually shorter than that of bond markets, typically 15 to 20 years. Stock markets have gone nowhere since the peak in 2000 so it also seems realistic to assume that this cycle seems to be in a mature state.

So is it possible that the recent surge in stock prices is the start of a longer-term bull market? Eventually central banks have to normalize monetary policies and there will be less cheap money flowing into markets. Many fear that once this starts to happen, equity prices are going to drop significantly. Again, looking at history, this concern doesn't seem justified. Actually, the opposite is true. Turning points in interest rate cycles have normally also been turning points for equity markets and rising yields do not cause a selloff in equities. This means that in coming years we could see the current spike in equity prices turn into a structural bull market for equities, even if central banks eventually start to hike rates.

Another indication that the pressure is easing - falling bond yields/increased refinancing

Higher interest rates are not always a bad sign for an economy and as long as the increase takes places over a certain period of time, higher rates are not necessarily triggering a selloff in equity prices. While interest rates remain low in many parts of the world, we believe that yields are slowly starting to turn around. Over a time frame of 12-18 months we see a continuing normalization of interest rates, higher economic activity and renewed growth momentum in corporate profits.

What are the risk factors that could bring back renewed, negative market volatility? A few come to mind, but we think that neither the European debt crisis nor the U.S. deficit story are changing things in a meaningful way. We are more concerned about geopolitical events such as the situation with North Korea or Iran. Especially close we are watching the situation with North Korea with great concern. While the recent actions by the North Korean regime have failed to impact markets negatively, the risk in our view is that a small event or accident could trigger military actions from North and/or South Korea. Such an event could further destabilize the region and cause enormous uncertainty among financial markets worldwide. For now, we still think this is a low probability event but it needs to be monitored very carefully.